A Model of Momentum and Market States: Theory and Evidence
55 Pages Posted: 2 Nov 2014 Last revised: 28 Mar 2019
Date Written: October 30, 2018
I develop a model that connects market states and momentum. The model analyzes asset pricing implications of two well-known psychological biases, overconfidence and self-attribution bias, in a setting of multiple risky assets whose payoffs contain a common factor. Due to self-attribution bias, overconfidence varies asymmetrically between winners and losers, resulting in asymmetric return behaviors between them. The model generates a set of implications regarding the relation between market states and momentum and long-run reversals. I find empirical evidence consistent with these implications.
Keywords: momentum, long-run reversals, overconfidence, self-attribution bias, market states
JEL Classification: G4, G12, G14
Suggested Citation: Suggested Citation